One of the fastest-rising trends in decentralized finance (DeFi) has been the concept of "real yield." The term has been popping in crypto media frequently, and it's a narrative that has been whetting Crypto Twitter's bear market appetite for weeks, but what is it?
Getting a Grasp on Real Yield in DeFi
In traditional finance (TradFi), real yield measures nominal returns minus inflation. For example, if a bond offers 8% returns on principle and inflation runs up to 7% during the bond's life, then the bond's real yield is 1%.
For DeFi, real yield has become a catchphrase for yields generated by economic activity and fees obtained from services provided. In addition to this feature, real yield (real yield farming?) proposes a model of DeFi where users' returns are based on protocols sharing their revenue for staking or locking tokens.
Moreover, this revenue needs to be denominated in blue chip crypto assets or stablecoins, which hold their value over time. By this definition, real yield does not include inflationary rewards tokens, farm tokens, or rebase tokens.
Why Has Real Yield Suddenly Captured DeFi's Imagination?
In short, real yield might be helping DeFi depart from the mindset of "free money printed out of thin air." At least, DeFi users once intoxicated by high APYs are currently facing a hangover as serious as the headache that followed participants caught in the burst of the ICO bubble.
Consequently, the DeFi community has grown wary of where they find their next opportunities for yield, even when it seems like a sure thing. In recent times, Terra's offer of 20% APY on UST serves as a cautionary tale in this light.
While 20% on stablecoins seemed like a conservative return set against OHM forks and other high APY products, the payout was sustained by what could be best described as a marketing budget. Calculations show that a good part of Anchor's APY for UST was not generated from lending or other sources of economic activity.
Without solid fundamentals driving the adoption of UST, Terra and its users created a house of cards that came tumbling down in a bank run. So much of UST's supply was deposited on Anchor at the time of its collapse that the stablecoin became unsustainably illiquid and susceptible to a de-pegging event–all to generate yield from…somewhere.
How Can DeFi Protocols Provide Real Yield?
A protocol needs to generate revenue before it can substantiate its claims to deliver its users real yield. As Sam Bankman-Fried pointed out in a DeFiant Podcast that aired in November 2020, DeFi protocols need to build services that users are willing to pay fees for, or else "when incentives are gone, what's left?"
However, this doesn't mean legitimate projects are in the wrong for bootstrapping their early days with inflationary token rewards. After all, incentivizing user cooperation with a protocol's own tokens is how Solana and Bitcoin compel validators to finalize new blocks honestly.
Similarly, governance tokens serve a purpose for decentralized autonomous organizations (DAOs) beyond providing financial yields. In late 2022, it seems like the DeFi community has woken up to the fact that most governance tokens are better suited for voting on improvement proposals than earning a profit.
That being said, if a governance token can also serve as a cash flow token, it's on track to becoming a source of real yield. And unsurprisingly, the ingredient that makes cash flow tokens a basis of real yield is capital entering the protocol in the form of fees.
If a protocol collects fees, it can share revenue with users who support the platform by staking or locking their tokens.
What Services are Attracting Users Who Pay Fees?
A recent spate of articles, blog posts, and tweets have identified DeFi protocols that share real yield with users who stake their cash flow tokens. Notably, most projects mentioned are either decentralized exchanges (DEXs) or services that optimize yield from a DEX.
The success of GMX and its cash flow token model has recently made it a paragon of real yield, and to date, the project has distributed around $60 million. Users who provide liquidity (LPs) earn 70% of GMX's revenue through the token GLP, and the other 30% is distributed in ETH or AVAX, depending on the chain, to users who lock in their GMX tokens.
In order to earn real yield, users have to stake or lock their tokens for a period of time. GMX has an impressive 86% of its tokens currently staked to earn real yield.
Curve, as well as its yield optimizers Convex and its cohorts, could also be classified as sources of real yield. Locking CRV earns users a portion of fees rewarded in the form of 3CRV, equivalent to holding a position in stablecoins. Still, much of the yield rewarded for locking CRV or CVX comes from inflationary CRV rewards and bribes.
Looking towards the future, Uniswap looks like it will get into the fees game with a recent governance vote to turn on its dormant fee switch at last. No one knows where these fees will go, but Uniswap is the most widely used DEX in all of DeFi, and the revenue potential is huge.
Considering P/E Ratios When Calculating Real Yield
A few considerations need to be taken into account when calculating the real yield generated by DeFi's real yield protocols. First, just because a project's yield is "real" doesn't equate to an insta-ape opportunity.
For instance, P/E ratios need to be considered to figure out the value of taking a position in a protocol's token to earn real yield. How much revenue is a protocol generating in relation to the price of its token?
At the time of writing, GMX has a P/E ratio of 20.8x, a value derived from dividing its market cap by the revenue it generates in a year. This means that if the price of GMX and GMX's revenues remained perfectly stable, it would take 21 years to recoup the initial cost of acquiring GMX–three times that many years if only staking GMX.
Turning to Curve, its P/E ratio is currently 380.0x, which doesn't look so hot. But, on the other hand, Curve's real yield is so heavily augmented by CRV–plus the demand for CRV, which has led to a whole CRV bribery ecosystem–that it's hard to say Curve's yield is not a significant source of revenue in DeFi, even if it's not 100% real yield.
Of course, the prices of real yield tokens will not remain static, and those positions can always be exited to recoup initial capital, breaking even, ahead, or behind. It should be noted that since these tokens must be staked or locked to begin earning rewards, anything can happen over the period of a multi-year time lock.
No one has a crystal ball for these things, but small-cap projects with revenue-sharing schemes can always end up leaving users happily surprised one day by their price performance and ability to deliver real yield, so the stats followed today have little bearing on future outcomes.
Does Real Yield Shift DeFi Towards Better Sustainability?
Maybe? Unfortunately, as soon as the "next big thing" breaks in DeFi, opportunists will be lining up to claim they have it. Already, some DeFi community members are warning users against getting too heads-over-heels with any project that promises real yield.
Nevertheless, pushing the DeFi narrative away from unsustainable APYs sourced from tokens born to grind to zero can't be bad. The future of DeFi depends on creating sustainable products and services with real utility, earning real fees, and delivering the community real yields.
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